Report No. 38357-RO Romania Municipal Finance Policy Note June 3, 2008 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank Acknowledgements Assistance, insights and information received from the authorities in Romania during the preparation of this Note is gratefully acknowledged. This Note was prepared by a team comprising Messrs./Mmes. h i t a b h a Mukherjee, William Dillinger, Joao Oliveira, Casandra Bischoff (ECSPE); Michel Noel, Sorin Teodom (ECSPF); and Sudipto Sarkar (ECSSD). The draft report was submitted to the Government in March 2007. The Government provided detailed comments on two sections of the report--the current chapters 1 and 3-411 June 2007. These comments on the two chapters havebeen fully addressedinthis final version of the report. Management oversight was provided by Sector Managers Messrs./Mmes. Deborah L. Wetzel and Ronald E. Myers (ECSPE); Sumter Lee Travers (ECSIE) and Gerrardo Corrochano (ECSPF). Guidance and comments from Messrs./Mmes. Satu Kahkonen and Ronald Hood (ECSPE); Marianne Fay (ECAVP); Benoit Blare1 (ECCUS); Keith McLean(ECSSD); Ellis Juan and Maria Freire (FEU) are also gratefully acknowledged. ROMANIA MUNICIPAL FINANCE POLICY NOTE TABLE OF CONTENTS Executive Summary ............................................................................................................. i 1 LocalGovernment Organization and Finance . .......................................................... Organizational Issues......................................................................................................... 3 3 Clarifying the Assignment o f Responsiblities 5 Addressingjurisdictional fragmentation ....................................................................... Delimiting the role o f the prefect ................................................................................... ................................................................ 6 Revenue Assignment and Intergovernmental Transfers ................................................... -7 -8 I s the transfer system sufficiently transparent and predictable? ................................ ............................................................. -10 Are local governments too transfer dependent?........................................................... I s the transfer system sufficiently equalizing? 11 13 2. .............................................................................................................. RaisingTariffs.................................................................................................................. Local Utilities 15 FinancingCompliance with EUDirectives...................................................................... 16 18 3.Reformingthe Sub-national Debt Market Legal and Regulatory Framework.,...............20 The Municipal Debt Market inRomania ................................................................ 23 Control o f local government borrowing ....................................................................... 24 Local government own-revenue guarantees 25 Short-term Treasury loans ............................................................................................ ................................................................. ................................................................... 26 Risk fund for local governments................................................................................. Local government bankruptcy framework 27 Risk weighting local government debt incalculatingbank capital adequacy ratio.....-27 Enforcement o fpublic procurement law on access to bankborrowing....................... 27 Highregulatory cost ofbondissuance......................................................................... 28 Improving Sub-national Entities' Access to the Sub-national Debt Market.. ..................28 (i) risksub-nationalentities(Tier1).................................................................... 28 Low 29 (ii) Medium-risk sub-national entities (Tier 2) ............................................................ 29 Technical assistance 29 Financial support .......................................................................................................... ..................................................................................................... 30 High-riskmunicipalities/municipalcorporations (Tiers 3 and 4) ................................ 31 Romania: MuniciDal Finance Policy Note Romania Municipal Finance Policy Note EXECUTIVESUMMARY i. MunicipalitiesplayanimportantroleintheRomanianpublicsector.Theyprovideavariety o f infrastructure services, either directly through municipal service companies, or through concessions. Among these services, water, wastewater, and solid waste assume particular prominence in the context o f EU accession, as Romania has undertaken obligations for their upgradingunder the environmental acquis. .. 11. Local Administration and Finance Throughout the 1990s and into the first years o f the present decade, problems in the structure o f intergovernmental relations undermined efforts to achieve efficiency in public service provision and generate savings for investment in local infrastructure. Ambiguities in the role o f the centrally-appointed prefect and a lack o f clear functional definitions in the organic law weakened accountability. The system for financing municipal government was particularly problematic. Romanian local governments rely heavily on transfers. The lack o f clear rules for distributingtransfers created uncertainty and allowed excessive influence to be exercised by central authorities and counties. iii. The2006publicadministrationreformhasaddressedmanyoftheseproblems.Theposition o f prefect has been delimited and professionalized. Recent legislation has clarified the functional responsibilities o f each tier o f subnational government. The recently adopted intergovernmental transfer formula also removes most o fthe discretion from the allocation system. iv. The effort to delimit the functional responsibilities o f each tier o f government has not yet been fully implemented, however. Plans for sectoral decentralization may contain the seeds o f a solution. The proposed education decentralization strategy-although currently on hold-would provide an opportunity to more clearly define the respective roles o f the Government, subnational governments, and individual schools in this sector. Certain relatively minor changes in the system o f intergovernmentaltransfers also bear consideration. v. Water Utilities: The water sector will bear the brunt o f the financing required to comply with EUenvironmental standards. Total investment costs are estimated at 9.7 billion between 2005 and the end o f the compliance period. While EU Cohesion and Structural Funds will be the main external financing source for the envisaged municipal investments, substantial counterpart funding will be needed. Given the fiscal constraints faced by central government, much o f this counterpart fundingwill haveto beraised at the sub-national level. vi. In principle, such funds could be generated by raising tariffs. At present, tariff revenue covers only two-thirds o f water companies' operating and investment expenditures. But recent studies show that even modest increases intariffs could be difficult for the poorest 40 percent o f the population. While tariffs should be allowed to increase, the burden on the poor should therefore be reduced through targeted subsidies. One approach would be to extend the social protection system now used in the district heating sector to cover water and wastewater services. Additional revenues could be raised from development fees, contract fees and the creation o f a municipal repair and development (MRD) fund. Further resources for investment could be generated by continuing to reduce operating costs. i Romania: Municiual Finance Policv Note vii. Domestic Credit: Access to domestic credit can also be an important means o f augmenting funding for infrastructure investment. Inrecent years, the local government debt market has taken off rapidly, although from a very low base. Domestic currency loans by commercial banks to local governments increased from RON 3.6 million in 2001 to RON 1,399 million in 2006 (or US$ 498 million). But the present structure leaves the Government vulnerable to pressure for debt relief, while encouraging lenders to take excessive risks. viii. The current Law on Local Public Finance (LLPF) requires the MEF to provide ex ante authorizations o f local government borrowing on a case by case basis. In effect, this requires it to assess the creditworthiness o f local governments for each new borrowing operation. The LLPF also allows a local government to guarantee its debt by pledging its own revenue; a guarantee that i s exercisable through the Treasury. Both provisions involve the Government too closely in what should be a distinct transaction between a local government and a private lender. By approving individual loans and acting as an administrator o f debt guarantees, the government may be unintentionally signaling markets that it stands as a defucto guarantor on all municipal debt. This is likely to give rise to reckless lending (on the part o f creditors) and pressures for government bailouts (on the part o f local governments). ix. Inresponse, MEF ex ante controls over local borrowing should be gradually phased out and replaced by market mechanisms (e.g. credit rating agencies). Other aspects o f local debt regulation should also be revised. The legislation governing municipal financial crisis/insolvency procedures should clarify issues such as the definition o f "essential municipal services" and the support the Government could provide (Treasury loans, allocations from the Government reserve fund) to local governments undergoing plans o f financial or insolvency recovery. Methodological norms for the application o f the local public finance law should specify how the Risk Fund should be used. It would be advisable for NBR to adjust its reserve requirements for municipal loans to reflect local credit ratings, with a risk weight o f 100 percent required in the absence of a credit rating. Finally, the Government should design and implement a coherent strategy to improve access to credit markets by local governments in the context o f the EU single market. This strategy should consist o f a range o f technical assistance and financial support instruments carefully modulated on the basis o f the risk profiles o fparticular sub-national entities inRomania. .. 11 Romania: Municbal Finance Policv Note Romania 1. LOCALGOVERNMENT ORGANIZATIONAND FINANCE 1.1 Romania needs substantial municipal investments to improve its local services and bring them to the standards required by the EU acquis communitaire. While the EU will finance a large part o f these investments, substantial counterpart funding will need to be mobilized from domestic sources. Given the fiscal constraints faced by central government, much o f the counterpart funding will likely have to be raised at the sub- national level, i.e. by local governments and municipal corporations. This policy note examines Romania's local government fiscal framework and sub-national debt market to see how improving them could facilitate absorption o f EU funds andimprove local service delivery. 1.2 The policy note i s organized as follows. Section Ireviews the local government structure and fiscal system and discusses how it can be improved to better enable local governments to efficiently fulfill their functions. Section I1 then examines the state o f municipal utilities. Section I11examines the recent evolution, opportunities and challenges ahead for the development o f the sub-national debt market, analyzes key deficiencies and proposes priority reforms in the legal and regulatory framework for local government borrowing, and proposes a strategy to increase the access o f sub-national entities to the sub-national debt market, based on a range o f technical assistance and financial support instrumentscarefully attuned to sub-national entities' riskprofiles. ORGANIZATIONAL ISSUES 1.3 Romania i s a large, unitary state. Its Constitution provides for a "public administration interritorial-administrative units based on the principles o f local autonomy and decentralization o f public services" (Art. 119). It also establishes (Art. 120-122): (i) directly elected local and county councils as deliberative authorities; (ii) directly elected local mayors and indirectly elected county council presidents as executive authorities; and (iii)centrally appointed prefects as coordinators for deconcentrated central agencies and supervisors for local self-government acts in each County. Prefects have the authority to check the legality o f the local council decisions and to suspend dejure the decisions o f the local councils, ifthey consider those decisions illegal. 1.4 Local authorities' organization, functioning, rights and responsibilities are specified in Law 215/2001 on "Local Public Administration'' (amended and supplemented by Law 286/2006); the Framework Law 195/2006 on Decentralization; Law 188 on the Statute o f Civil Servants (amended and supplementedby Law 251/2006); and Law 340/2004 on the role o f prefects (amended and supplemented by GEO 179/2005). Intergovernmental fiscal relations are regulated by Law 273/2006 on Local Public Finance, while Title IX o f the Romanian Tax Code (Law 571/2003 and amendments) specifies local taxes and fees. Law 500/2002 on Public Finance and Law 158/2005 on the Local Borrowing Authorization Commission regulate local government budgeting, auditing and debt management. Law Romania: Municival Finance Policv Note 326/200 1regulates municipal public services (including off-budget local utility providers). Law 213/1998 on regulates local government property ownership. However, the extent to which State properties have legally and effectively been transferred to local authorities i s not entirely clear, since registration procedures and the organization o f the cadastre system are still influx. Table 1.1: Romania Administrative Structure, 2005 - executive/legislative powers or separate budgets, the Deliberative bodies underjurisdiction ofi Central Government Local Self-Govt Adma RDAs have yet to take on a State Prefectures Counties Localities significant role. Parliament'Govemment 1 1 Supervisory/Coord. 42 42 County Councils 42 42 1.6 In fiscal terms, the LocalCouncildCities 104 lo4 LocalCouncils/Towns 207 207degree o f decentralization in LocalCouncildCommunes 2816 2816Romania i s fairly typical o f Total 1 42 42 3127 3212 Source: Ministryof Finance other unitary European countries. As shown in ' Bucharest municipality has a special status equivalent to a County, and is subdividedinto six Sectors. Diagram 1.1, Annex I. * With population between 2 and 3 million and surface size between 30 and 37 thousand square kilometers (except Bucharest). As a result o fthis transfer the shareo f localbudget innational education expenditure jumped to 56 in2001, from 10 percent during the period 1995-2000. 4 Romania: MuniciDal Finance Policv Note Clarifyingthe Assignment of Responsiblities 1.7 Prior to 2006, local government responsibilities were not clearly defined. The organic Law on Local Public Administration (Law # 215/2001) regulates the organization and functioning o f county and local council authorities (deliberative and executive) but focuses on processes and procedures, rather than the assignment o f specific responsibilities. Separate laws, emergency ordinances, official government decisions, and the State annual budget law governed the role o f local government in specific sectors, albeit not always con~istently.~ By and large, the Government retained most policy decision-making powers at the center, while local governments were responsible for implementation. Counties were charged with Figure 1.1 Local Govt Expenditure as % coordinating local service delivery, including General Govt the task o f balancing local government budgets Denmark 2004 io through equalization transfers. Sweden2005 I43 Finland2005 9 1.8 In 2006, the Cabinet approved a ireiand2004 9 Memorandum defining the role o f county and Belaws 2004 local governments and distinguishing among Netherlands 2005 exclusive, shared and delegated functions. The Italy2004 NOmay2005 Memorandumincludes two annexes, describing Poland 2005 the specific role of each tier o f subnational UK 2005 government in the regulation, implementation, Ukraine2005 Hungary2005 and financing o f specific services and in the Estonia 2004 ownership of related facilities. As shown in Moldova 2005 Annex Table 1.2, county governments would Lithuania2005 bear responsibility for delivering water supply Latvia 2005 Romania2004 (ifa regional operator has been created), county Czech2005 roads, public transport (in conjunction with France 2005 private operators), the maintenance o f county- Slovenia 2005 Austda 2004 level health clinics and the county guard service. Slovakia 2005 The central government would bear exclusive Bulgada2004 regulatory responsibility in all these areas and Belgium 2004 would retain a role in financing county roads Croatia 2004 Greece 2005 and the maintenance o f health clinics. As shown 0 20 40 60 80 in Annex Table 1.3, local governments would retain an extensive list o f functions, including water supply (if not provided by a regional company), district heating, waste management, local public transport, local street maintenance, and certain aspects o f health care, education, and social assistance. This legislationincludes, among others, LawsNo. 8411995, 12811997,27012003,63412002, 19412003, 312003, 19412003,47512003,28412002, 11412002,3631202,48112004, 1712000,21712003,41612001, 34312004,48 112004,1512005;EOG 7012002, 3212002,3512003 ,73l2002,2512004; GD 34812003,40012003, 53912005, 82812003,955l2002, 100712005, 102112000, 138612003, 149112004, 156112004, 159112002, 135312003,43312004,34612004; Ord 29m11993, 6812003,7012002,7312002,25912004,23312004; HG 93312004 5 Romania: Municival Finance Policv Note 1.9 While the Cabinet Memorandum represents an important effort to define the respective responsibilities o f each tier o f government, ambiguities and overlaps nevertheless remain. Some functions are assigned to both county and local governments. In the area o f socio-medical assistance services, for example, local governments are responsible for `ensuring proper conditions for service delivery' ,while the social medical assistance unit, subordinate to the central government, has the responsibility o f delivering the service. In some other cases the responsibilities are assigned on an optional basis. Shelters for the elderly, for example, may be provided by local governments, but only if they `undertake it as an exclusive responsibility and have the necessary administrative capacity. ' The Ministry o f Interior and Administrative Reform is still working in defining criteria for the `administrative capacity'. 1.10 To an extent, the problem has been worsened by stalled efforts at functional decentralization. The decentralization o f police responsibilities, for example, was intended to establish community police units at the local level. Major problems occurred after the functional competencies were reallocated, however, with a vast number o f small local government units unable to establish the new community police units due to lack o f resources. (See Box 1) Reforms in social assistance were intended to permit local governments to top up entitlements but have left several areas o f undefinedresponsibilities between county and local councils. 1.11 In 2006, an Inter-ministerial Working Group was established to design and coordinate the implementation o f sectoral decentralization policies. However, the Working Group has met only a few times since then and has not been able to reach a consensus on major issues. Plans for further sectoral decentralization, nevertheless, hold the seeds to a solution. The new education decentralization strategy proposes to shift more authority to school boards. Although the strategy i s currently on hold, it would provide an opportunity to more clearly define the respective roles of the Government, subnational governments, and individual schools inthis sector. Delimitingthe role o f the prefect 1.12 Under article 112 (4) o f the Constitution, the prefect has de jure authority to immediately suspend local self-governments' decisions if he deems them illegal and challenges them in Administrative Court. Until recently, the excessive powers o f prefects undermined local government autonomy. Prior to 2006, prefects were political appointees. Box 1.1 Decentralizingthe Police Inpreparation for EUaccession,Romania adopteda law (371/2004) establishinglocal community police, who were to take such functions as patrolling and guarding from the national police. The devolution was to be carried out by creating Community Police Units at the local level, using funds and staff transferred from the existing Safety and Patrol Units. What seemed simple in theory became a complex in practice. It was quickly discovered that the Safety and Patrol units did not have enough resources themselves and therefore had few to transfer. In some cases, community police units were given only bats but no guns. Hiring criteria also proved to be a problem. Staff inthe community police units were required to meet a minimum schooling requirement of twelve years, rendering almost half the staff o f the Safety and Patrol Units ineligible. As a result, one year after the law went into effect, only half of large cities and only four percent of communes had establishedthe Community Police Units. 6 Romania: MuniciDal FinancePolicv Note They had the authority to appoint the secretaries o f local and county councils, which gave them indirect influence over local decision-making.' 1.13 The 2006 public administration reform addressed most o f these concerns. The role o f the prefect was reviewed and depoliticized by transforming the position from that o f a political appointee to a high civil servant and by promoting a more active role for the Administrative Courts in conflict resolution. Starting with 2006 the prefects are selected through a national competition held by a permanent independent commission appointed by the Prime Minister. The members o f the commission are appointed by rotation and have a predetermined ten and a half year mandate. Inaddition a general performance appraisal o f each high civil servant must be carried out every 2 years. The reform also provided that secretaries of local authorities would be appointed and dismissed by the local authorities themselves, instead o fby the prefect. Addressingjurisdictionalfragmentation 1.14 Many o f Romania's local governments are quite small. As shown in Figure 1.2, 92 percent o f local administrative units have less than 10,000 inhabitants and 71 percent have less than 5,000. These two groups o f units cover 45 percent and 27 percent o f the population respectively. It has been argued that, due to their small size, such governments cannot exploit economies o f scale and have difficulty attracting qualified staff. International evidence suggests otherwise. International efforts to demonstrate economies o f scale in the provision o f municipal services have generally proven inconclusive.6 The evidence suggests that population size i s not a decisive variable in determining the cost or quality o f public services. The literature suggests, in fact, that where populations are geographically dispersed, there are few technical economies o f scale to be gained by incorporating them into a single largejurisdiction. It does, however, suggest that there are economies o f scale in the use o f skilled (and therefore expensive) staff. These however, can be addressed by contracting with private providers, joint service arrangements, or by employing skilled staff on a part time basis. (It is worth noting that Romanian local governments are not particularly small by European standards. As shown inTable 1.4, they are considerably larger, on average, than local governments in Germany or Spain and more than four times the size o f the average French commune.) 'Although Law # 215 states that there is no hierarchical relationship between local public authorities and County Councils, this provision i s honored inthe breach. This literature is surveyed inDillinger, William. 2003. Latvia: Beyond TerritorialReform (World Bank Report No. 25466-LV) and inWilliam F. Fox and Tami Gurley. 2005. Will ConsolidationImprove Sub- National Governments? 7 Romania: MuniciDalFinance Policv Note Fig. 1.2 Romania: Sire distribution localities and - 60 0 50 0 400 r c 300 e "t200 100 0 0 Localities'size brackets(in thousand inhabitants) 1.15 There is a final lesson to be drawn from international experience. Territorial consolidation can be extremely unpopular. Small communities resist incorporation into larger jurisdictions, fearing their interests will be submerged in the larger polity. Among the recent EU accession countries, only one (Lithuania) has successfully implemented a territorial consolidation in the post-Soviet period. Ifsuch resistance exists in Romania, the costs o f attempting consolidation may not be worth the effort. Efforts at improving the efficiency o f local government could instead focus on facilitating intergovernmentalcooperation and the use o fprivate contractors. REVENUEASSIGNMENTAND INTERGOVERNMENTALTRANSFERS 1.16 The assignment o f revenues to local government in Romania is regulated by Law 273/2006 on "Local Public Finance" and Title IX o f the Romanian Fiscal Code (Law 571/2003 and amendments). As shown in the chart below, the largest single source of local government revenue consists o f earmarked transfers, accounting for about 36 percent o f the total. These largely consist o f funding for teachers' salaries. As noted earlier, local government have virtually no say inthe use o f these funds, acting merely as paying agents. Issues inthe financing o f education are beyond the scope o f this paper. 1-17 Local own taxes,fees and charges. The sources over which local government do have some discretion fall into three categories. The first, local own taxes and fees, accounted for only about 17 percent o f total revenues in 2006. These include property taxes (on buildings, land, and motor vehicles) and a hotel tax. While the base and reference rates o f property taxes are determined by law, each local or county council can adopt a rate up to fifty percent higher or lower than the reference rates. There are also a myriad o f legally regulated fees, most o f them belonging to local councils (e.g., advertisement fees, entertainment fees, temporary road use fees). Some are shared with county councils (e.g.,planning licenses, buildingpermits, businessregistration fees). Some are special fees and charges that either the local councils or county councils are allowed to establish and c01lect.~ Local tax administration in Romania i s decentralized. Each E.g.,late payment interest and fees, judicial stamps, stamp duties, extra-judicial stamp duties, sanitary- veterinary fees, slaughter house fees, dog license fees, hunting and fishing fees, disease and pest control fees, nursery school fees, and other fees. 8 Romania: Municiual Finance Policv Note administrative unit is allowed to administer its own taxes, fees and charges. In general communes and small towns use the tax administration services o f the respective county. All such revenues musttransit the National Treasury system' and are therefore subject to a certain degree o f central government control. 1.18 Shared taxes Shares o f profit and income taxes' account for about 27 percent o f I local revenues. These Figure 1.3 Romania: Composition of Local Govt. Revenue are distributed among 100% subnational governments on a 80% derivation basis, according to the 60% taxpayer's place o f earmarked transf work." Funds are 0 equalizationtransf 40% shared income tax distributed among the tiers o f government as 20% follows: 47 percent remains with local 13 0% governments, 2001 2002 2003 2004 2005 2006 percent with the county council, and 22 percent i s allocated to an "equalization pool" at the county level for subsequent distribution to local government on the basis o f a formula, discussed below." The remaining 18 percent i s retained by the central government. 1.19 Equalization transfer The third major source o f discretionary revenue, accounting for 16 percent o f the total, is the so-called equalization transfer. Romania has been experimenting with formulas for distributing the equalization transfers for several years. Previous versions were criticized for their complexity and for the degree o f discretion they granted to counties. (As noted earlier, counties had the authority to allocate equalization grants amongtheir respective local governments at their own discretion.) 1.20 A new system went into effect inJanuary o f 2007." It consists o f six distinct steps. First, a lump sum i s allocated from general central government budget revenues. When the system was first promulgated, it was announced that the lump sum would be based on a combination of the unshared portion o f the PIT--the remaining 18 percent--and the VAT, In the event, the amount was determined at the discretion of the government. It was 'All operations o f the consolidated budget (comprising all the Romaniabudgetary system: including the State Budget, the Social Security System, Special FundBudgets, institutions fully or partially financed by the State budget, and the Local Budgets) has to be registered by the National Treasury System. Including personal income (PIT), and incomes o f independent activities and micro-enterprises. lo The profit tax liability o f local government's autonomous public enterprises ("regies autonomones," including utilities) is directly collected to the respective administrative unit's budget, but profit taxes from all other sources belong to the State budget. "BucharestCitybudgetretain47.5%, BucharestCitydistrictbudgetsretain23.5%, and11%goestoan "equalization pool" to be subsequently allocated to Bucharest City district and Bucharest City. Certain aspects o f the law, including the division o f equalization funds between counties and local governments, went into effect during 2006. 9 Romania: Municbal Finance Policv Note reflected in the annual budget law, rather than in permanent legislation, and is therefore subject to annual change. 1.21 The lump sum i s then distributed among counties. Thirty percent i s distributed on the basis o f land area. Seventy percent i s distributed on the basis o f `fiscal capacity'. This i s determined by calculating a `fiscal gap' for each county as the difference between the per capita PIT tax revenues o f the county and the average for all counties, multiplied by the population o f the county. Fiscal gaps are then aggregated for the country as a whole. Each county's share o f the aggregate fiscal gap determines its share (of this portion) of the lump sum. 1.22 For each county, these shares are then added to the 22 percent o f the PIT collected within each county to form a consolidated pool. Twenty five per cent of the consolidated pool i s assigned to the county government. The rest i s assigned to the local governments within the county. O fthis amount, 15 percent is allocated to capital works. (The allocation i s determined by the county council and i s used primarily to provide counterpart financing for externally financed projects.) The remaining 85 percent i s allocated among the local governments inthe county through an iterative, three stage process. 1.23 In the first step, half o f the money is distributed to municipalities whose PIT revenues per capita are less thanhalfthe county average. Seventy percent o f this amount is distributed on the basis o fpopulation and 30 percent on the basis o fbuilt-uparea. No local government, at this stage, receives more than the amount that would be sufficient to bring its per capita PIT revenues up to the county average. Any excess i s added to the remaining 50 percent o f the first stage pool and distributed among local governments whose per capita PIT revenues fall between 50 percent and 100 percent o f the county average (including local governments that have achieved this status by virtue o f transfers received inthe first iteration). This pool is then distributed among the eligible local governments, again on the basis o f population (70 percent) and built-up area. The amount o f the transfer i s again capped at the level required to bring the jurisdiction up to the county average. Funds remaining from the second iteration are subject to a third iteration, for which all local government are eligible. Funds are distributed, this time, on the basis o f populated- weighted fiscal gaps-i.e., the same system used to distribute the original lump sum among counties. This exhausts all funds. There is, nevertheless, a final step in the allocation process. Inorder to encourage local revenue mobilization, Article 33, paragraph 4(h) provides that equalization transfers will be reduced for any local government reporting a decline inrevenue from local taxes, fees, rents and dues. For each lei that revenues from these sources declines, a lei o f equalization transfers is deducted. These deductions, if any, are pooled at the county level and added to the funds to be used for counterpart financing for externally financed projects. I s the transfer system sufficientlytransparent andpredictable? 1.24 A long-standing critique of the Romanian transfer system has been its lack of transparency and predictability. This issue i s not unique to Romania. One o f the principal challenges facing all the post-Socialist counties o f Europe was to devise a system for financing local government that would be perceived as fair and stable. The emergence o f multi-party democracy required transparency in order to allay charges o f partisan 10 Romania: Municinal Finance Policv Note favoritism and reduce the transaction costs that would result from continued reliance on bargaining. Predictability was required to provide local governments with a stable basis for budget planning. 1.25 The new Romanian transfer system largely meets this test. The share o f the PIT to be used for equalization i s fixed in law (22 percent), as i s the basis on which it i s to be distributed among the counties (derivation). The formula for distributing each county's consolidated pool among individual local governments is also largely fixed in law. (The only exception i s the 11.25 percent (15 percent x 75 percent) reserved for counterpart finding.) While the multi-stage system used to distribute the consolidated pool among local governments i s extremely complicated, it is based on a small number o f readily measured variables (population, PIT revenues, land area, and built-uparea) and is entirely mechanical. In principle, there i s no room for discretion in the calculation o f each jurisdiction's share. 1.26 The only major source o f uncertainty in the transfer system i s the amount o f the lump sum. As noted earlier, this is subject to annual budget negotiations. To address this problem, the Government could consider enshrining the rules governing the determination o f the lump sum in a more permanent form o f legislation, such as the law on local public finances. Such legislation could establish a mechanism for determining the overall amount o f the transfer each year-as a fixed share o f aggregate national tax revenue, for example. Although some o f the recent EU accession countries tie the level o f transfers to a single tax-usually the PIT-this leaves local governments hostage to the vagaries o f a single tax base as well as the legislation governing it. To provide for flexibility, these provisions could be subject to periodic review at, say, five year intervals, by a high level group including representatives o f the relevant ministries at the central level (including the Ministry o f Finance) and the associations o f local governments. I s the transfer systemsufficientlyequalizing? 1.27 A second critique of the transfer system is that it is insufficiently equalizing. The transfer system at present has two somewhat contradictory components. The origin-based portion o f the PIT essentially returns money to where it was collected. This results in substantial disparities among jurisdictions. The equalization system then reduces those disparities. It does so in several ways. First, 70 percent o f the lump sum i s distributed among counties accordingto fiscal capacity. This favors counties with weak tax bases. The remaining 30 percent i s distributed on the basis o f land area. This favors rural (and presumably poorer) counties. Third, the three-stage process used to allocate the municipal share in each county favors jurisdictions with below-average per capita PIT revenues. Still and all, the system leaves 47 percent o f the PIT to be distributed on the basis o f origin, as well as 100 percent o f collections from property taxes, fees and other local revenues. Moreover, the 22 percent o f the PIT reserved for equalization i s first allocated to individual counties on the basis o f origin. As a result, even this component o f the transfer system begins by favoring counties with strong tax bases, or more precisely, municipalities in counties with strong tax bases. 11 Romania: Municiual Finance Policv Note 1.28 Should the government try to increase the level o f eq~alization?'~The case for further equalization would be compelling if local governments relied on transfers to finance functions with important distributional implications, such as teachers' salaries, social assistance, or the operating costs o f primary health clinics. One could argue that all Romanians have the right to a basic level o f education, health care and income security. But inRomania, such expenditures are largely financed by the central government, either inthe form of earmarked transfers (such as the transfer for teachers' salaries) or through direct payments to facilities (as i s largely the case for primary health). Any increase in the redistributive element o f the transfer formula would instead redistribute funding that i s largely used for community services and top-up to central government expenditures. 1.29 Several smaller changes could nevertheless be considered. First, the definition o f the origin o f PIT revenue could be changed from place-of-work to place-of- residence. People commuting across jurisdictions to work presumably use more local public services in the place where they live than in the place where work. Garbage collection, street cleaning, and parks are all primarily residential services. Existingtax data may not permit this refinement, however, if payroll records do not show the place o f residence of individual workers. Data permitting, however, this reform bears consideration. 1.30 Second, the tax collection incentive could be removed from the equalization transfer. As presently formulated, this incentive merely punishes local governments that are experiencing absolute declines in own source revenues. It does not distinguish declines due to local economic conditions--which are beyond the control o f the local government-- from declines due to lax tax administration or deliberate reductions in tax rates. A system that responds to ajurisdiction with a declining economy by cutting its transfers is difficult to justify. Ifthe aim o f this incentive i s to encourage local tax effort--a questionable aim in itself--the Government would need an uniformmeasure o f the tax base o f eachjurisdiction. This does not exist. Nor i s it likely to exist in the future, since each jurisdiction i s responsible for its own tax administration.. 1.31 Third, the PIT component o f the equalization fund could be pooled at the national level, rather than first being transferred to each county on the basis o f origin. This would reduce the rather arbitrary disparities among local governments indifferent counties. 1.32 Finally, the Government could consider simplifjmg the process for distributingthe equalization pool among municipalities. The present system goes to great pains to ensure that no municipality receiving equalization transfers emerges with a level o f per capita revenues higher than the national average. Much the same effect could be achieved by collapsing the three-stage process into a single one: calculating the total size o f the revenue gap (as the amount that would be required to bringthe per capita PIT revenues o f all local governments up to the national average) and pro-rating the amount o f the distributable pool among them in proportion to their share o f the gap. As long as the size o f the pool i s less than the aggregate gap, no jurisdiction receiving transfers would emerge with more than l3Inthe absence ofdata for 2007, it is difficult to determine how wide the disparities resulting from the new systemactually are. Calculations based on the former system show that the equalizationtransfers did dramatically reduce variations among jurisdictions. In2005, the coefficient of variation inlocalper capita revenues (including local taxes and fees and the origin-based portion of the PIT) was 1.49 (excluding Bucharest). The equalizationtransfer reduced this figure to 0.67. 12 Romania: Municipal Finance Policv Note the average level o f per capita revenues. An even simpler approach could be considered.. The entire PIT-including the 47 percent distributed to local governments based on origin-could be allocated to the equalization pool and then distributed among all jurisdictions on a per capita basis. 1.33 A recent review of transfer reform options for Romania14suggested several other refinements. One would be to add more factors to reflect variations in `need'. This should probably be avoided. As the report itself illustrates, variations in need are extremely difficult to determine-particularly for the sort o f services provided by local governments. How much i s needed to subsidize water companies (particularly when the alternative o f raising tariffs exists)? How much i s need to finance discretionary top-ups o f central government expenditures? In effect, the current system uses population, and to a smaller extent, land area and built-up area, to measure need. In the absence o f any major redistribution fimctions to be financed from discretionary revenues, this appears sufficient. Figure 1.4 Sources of Local Revenue A r e local governments too Selected European Countries transfer dependent? France2005 Italy2004 Austna 2004 1.34 Nearly 80 percent o f Czech2005 subnational government Belgium2004 revenues are derived from Hungarj200S transfers, including earmarked Bulgana2004 Romania2006 grants, shared transfers and Poland2005 equalization grants. Even leaving Slovakia2005 aside earmarked grants for Moldova2005 education, the figure remains UK2005 Slovenia2005 over 70 percent. Counties and Ukraine2005 communes are most dependent Latvia2005 on transfers, with own revenue Nethdands2005 sources contributing as little as Croatia2004 Lithuania2005 8.5 percent and 16.6 percent, Nomay2005 respectively, to their budgets. Estorwa2004 Even municipalities bare1y Ireland2004 manage to finance one fourth o f Denmak22004 Finland2005 their expenditures through own Sweden2005 source revenues. It has been 0% 20% 40% 60% 80% 100% argued that counties and local governments are excessively reliant on intergovernmental transfers. Critics have -charged that transfer reliance undermines local accountability by severing the tie between taxes paid and services received. There i s little empirical evidence for this assertion, however. 1.35 Moreover, practice suggests otherwise. As shown inFigure 1.4, the level o f reliance on local taxes, including personal income taxes distributed on the basis o f origin, l4Martinez-Vazquez, Jorge, et.al. December 2006.Equalization Transfers in Romania: Current System and Proposalsfor Reform Georgia State University 13 Romania: Municipal Finance Policv Note i s not unusually low by European standard^.'^ This suggests, at least, that similarly situated countries have found the benefits o frelying on transfers-which include the ability to redistribute resources amongjurisdictions and to minimize the costs o ftax administration-to outweigh the costs, ifany o f doing so. 1.36 There i s a persuasive case for assigning local governments a relatively broad based tax which they can use to increase (or decrease) revenues on the margin. This can provide them with a means to respond to local demands for increased spendingwithout resorting to ad hoc assistance from the central government. But Romania already has such an instrument, in the form o f the property tax. As local governments directly administer the tax and have considerable latitude over the rate, this is sufficient to provide the required degree o f local revenue flexibility. Figures for `local taxes' inRomania includes fees and charges that are classified under `other revenues' for the other countries shown on the table. 14 Romania: Municival FinancePolicv Note 2. LOCALUTILITIES 2.1 Municipalities provide a variety o f infrastructure services, including water and wastewater services, transportation, district heating, and solid waste management. These services are provided either by a department within a municipality or through utilities that are commercial in nature-most o f which are public although there are a few private entities as well. The operations o f these utilities are largely financed through tariffs and fees, rather than taxes. Their investments are supported through the internal cash generation, funds fiom the municipalities in some cases, and through borrowing. This section briefly examines the provision and financing o f one such sector--water and wastewater services. This sector, along with solid waste management, has assumed particular prominence in the context o f EU accession, as Romania has undertaken obligations for their upgrading under the environmental acquis, obligations estimated to require investment o f about 9.7 billion between 2005 and the end o f the compliance period for the various sectors (2015 for water, 2017 for solid waste and 2018 for wastewater)I6, 2.2 Water and wastewater services are provided by some 950 regional and local utility companies. These utilities, run by commercially-oriented operators, have concession or service contracts with either the County Council or the Local Council. Most operate within the municipal structure, although 74 are now independent corporate entities and a few, notably the Bucharest andPloesti concessions, have foreign private management. 2.3 Whether public or private, the utilities function under the oversight o f the regulatory agency for local public services, Autoritatea Nationala de Reglementare pentru Servicii Publice de Gospodarie (ANRSC), which covers all services except water and wastewater in Buchare~t.'~The ANRSC mandate includes services related to water, wastewater, solid waste management, district heating, and urbanlighting, and includes: a) Providing licenses to operators and supervising the procurement process to select operators; b) Endorsingand/or approvingthe prices and tariffs for public services; and c) Establishing criteria and minimumperformance indicators regarding the quality o f public services under itsjurisdiction, inline with the EUrequirements. 2.4 The ANRSC, founded in 2002, became functional in 2003 and has slowly expanded the scope o f its operations across its sectors o f responsibility. At present it has registered some 60 water and wastewater utilities. Government is encouraging consolidation o f the water industry, with a goal o f reducing the current 950 to 40-50 I6 The RomanianWater Association reports the EUcompliance (water pluswastewater) total at 15.1 billion. l7For Bucharest, the concession contract established a separate body, the Bucharest Regulatory Agency for Water Supplyand Sewerage (ARBAC). 15 Romania: MuniciDal FinancePolicv Note regional operators by 2015, a move that could make it much more manageable for the ANRSC to cover the universe o fwater utilities. 2.5 A new legal and regulatory framework for public utilities was adopted by Parliament in 2006 and will come into force on March, 21, 2007. This consists o f Law 51/2006 on community services in public utilities (promulgated in March 2006), Law 241/2006 on drinking water and sewerage services (promulgated in June 2006) and Law 325/2006 on district heating services (promulgated inJuly 2006). RAISINGTARIFFS 2.6 Law 5112006 establishes the legal and institutional framework, and the objectives, competences and specific instruments for the set-up, organization, management, financing and monitoring o f community services inpublic utilities. The Law stipulates that the prices andtariffs for community services providedby operators are established basedonthe methodology elaborated by ANSRC. The tariffs cover operations, maintenance and repair costs, assets depreciation costs, environment protection costs, financial costs associated with contracted loans, fees for management contracts, a quota for the development and modernizationo fnetworks, and a quota for profits. Figure 2.1 Householdexpendituresonwater, sanitationand solidwaste, as a share of householdincomeand consumption,2004 E 16% 7 Q 14%? p 0% 4 1 2 3 4 5 6 7 8 9 10 hcom deck Source: World Bank staff estimates based on 2004 Family Budget Survey. Figures represent median by decile, and include total expenditure on water, sanitation and solid waste, not payment to utilities alone (if any). 2.7 Law 241/2006 on drinking water and sewerage services indicates that the tariff for these services i s to be established inaccordance with the provisions o f Law 51/2006. Inthe application o f Law 241/2006, the ANSRC published for consultation a Draft Norm describing the methodology for establishing and modifying the tariffs for water and sewerage services. The Draft Norm identifies each cost component to be included in the tariff as described above. It establishes a quota o f 10 percent on profits for municipal water utility companies. The Normwill come into force on the same date as the above Laws. 2.8 Romania does not have a unified database o f tariff or operational information on the water and wastewater sector. From the partial information available, tariffs vary 16 Romania: Municipal FinancePolicv Note widely, with those for water supply rangingfrom 0.15 to 0.55 per cubic meter and wastewater from 0.18 to 0.45 per cubic meter." A separate source reports on average revenue per cubic meter o fwater sold, indicating that it stands at about $0.36.'' Family Budget Survey data indicate the stress level placed on households by sector expenditures. 2.9 These tariff levels, combined with a growing meteringlevel, have encouraged increased water consumption efficiency, bothoverall and within the household sector. At an aggregate level, water consumptionhas declined reflecting substantial decreases inper capita consumption. These results are consistent with another report that per capita consumption averages 146 lpcd outside o f Bucharest. Figure 2.2 Water consumptionin Romania, total andper capita, 1997-2004 1997 1998 1999 2000 2001 2002 2003 2004 Source: RomanianWater Association at http://www.ifat.de/frontendlmediaivortlaege_cashflow/monta~water-supply-and-sewe~ge-systems-in-roma~a.~f 0 Evidence o f impressive gains in consumption efficiency i s matched with the very partial results on operational efficiency.'O These show, for example, that the number o f staff per connection has fallen from 14.6 in 2000 to just over 3 in 2005. The same source reports an average operating cost ratio o f 1.32 in2005, consistent with the ability to deliver sustainable service at the current level, although not answering the question o f financing the additional investment and attendant operating costs required with EU accession. In 2004, the Romanian Water Association reports that tariff revenue o f 357 million covered approximately two-thirds o f the combined operating and investment costs o fthe systems." ''https://www.uktradeinvest.gov.uk/ukti/ShowDoc/BEA+Repository/345/3figure, 87926 httu://www.ib-net.org/index.phtxNote that revenue is an actual collection not a tariff. The universe o f reporting utilities may differ betweenthe two measures. *'http://www,ifat.de/frontend/media/vo~aege_cashflow/montag/water_supply_and_sewerage_systems-in-romania.pdf 'Ohttp://www,ib-net,org/index.php 17 Romania: Municipal FinancePolicv Note 2.11 Given the estimated magnitude o f investments needed to comply with acquis undertakings and the level o f current tariff revenues, financing EU obligations presents a substantial challenge for Romania. In 2004, with relatively low tariffs, median expenditures on water, sanitation and solid waste were 4.7 percent o f household income amongst the first decile, and around 4 percent among the second, third and fourth deciles. This suggests that even relatively modest increases in tariffs could be problematic for the poorest 40 percent o f the population unless compensatory measures are designed. The Government Strategy states that "tariff increases for the service should be limited to general affordability levels, and at the same time[. ..] reduce consumption" (Government o f Romania, undated, p. 13). The Government's Strategy defines the affordability ceiling at 3.5 percent o f household income for water and sanitation and an additional 1percent for solid waste services. 2.12 Reconciling increases inmunicipal water tariffs that are required by the provisions o f Laws 51/2006, 241/2006 and the associated ANSRC Norm with the affordability ceilings defined under the Government Strategy will require significant improvements in the social protection mechanisms for lower income groups. Inparticular, it i s advisable for the Government to carefully assess the benefits and costs o f alternative approaches to ensure the affordability o f water and wastewater services for low-income households. This could include extending the existing social protection system in effect in the district heating sector to cover water and wastewater services, or designing and implementing a targeted Output-Based Aid (OBA) scheme across all sectors based on international experience. FINANCING COMPLIANCEWITH EUDIRECTIVES 2.13 The EU Cohesion and Structural Funds will be the main external financing source for the envisaged municipal investments. Romania has finalized its Sector Operational Program for the environmental sector which lays out the country's plan to meet its EU commitment and covers the period 2007-2013. This estimates a total cost for the periodo f 4.9 billion (Table 2.1). Romania i s now preparing more detailed implementation plans for the SOP. Table 2.1 DraftEnvironmentalSector OperationalProgram: Cost and Financing ( million) Year cost Financing Pian - Structural Cohesion Local Central Funds Funds Government Government 2007 424.26 100.00 248.00 19.21 57.05 2008 616.10 133.00 376.00 28.81 78.30 2009 85 1.40 191.00 508.00 40.57 111.83 2010 932.43 231.00 528.00 45.12 128.31 2011 865.66 271.OO 416.00 41.78 136.88 2012 610.37 197.00 284.00 30.02 99.35 2013 605.66 197.00 280.00 29.78 98.88 TOTAL 4905.88 1,320.00 2,640.00 235.29 710.59 Source: World Bank2006. 18 Romania: Municipal Finance Policv Note 2.14 The indicative financing plan presented above relies on a substantial increase on central government contributions. A substantial share o f the financing requirements for the environmental SOP will also have to be met at the local level. However, local governments must respond to a much broader set ofbudget demands thansimply water systems and the Government's Strategy for Streamlining the Development o f Community Public Utility Services recommends that no more than half o f the 20 percent limit (Le. 10 percent) o f public debt service be allocated to community public utilities. Consequently, a substantial portion o f SOP financing requirements will need to be mobilized by local utility companies themselves. 2.15 This in turn requires that local utility companies continue ongoing efforts to improve operational efficiency, and that local governments raise municipal water tariffs to cover the cost o f equity and debt financing o f local utility companies' investmentsin line with the provisions o f Laws 51/2006 and241/2006 and associated ANSRC Norm. 2.16 At the municipal level, tariffs can be augmented by additional revenue sources, including a Development Fee, a Contract Fee, a Municipal Repair and Development (MRD) Fund, or the Local or County budget. However, the fees and Fundgenerate their revenue from the same set o f consumers under tariff stress, limitingtheir application. 2.17 In sum, there are fairly good estimates o f the investments needed for Romania to comply with the EU directives. However, financing these investments poses a substantial challenge for the authorities: public resources are limited by tight budget constraints, commercial financing i s not easily available for many municipalities due to their lack o f creditworthiness, and many local utility companies have difficulties securing commercial financing because existing tariffs do not cover the equity and debt financing cost o f their investments, in particular in the water and wastewater sector. The gap between currently available resources and the total financing demands in the water and wastewater sector highlights the urgent need for the Government to establish conditions that will enable sub- national entities to finance their infrastructureinvestments on the sub-national debt market. 19 Romania: Municival Finance Policv Note 3. THE MUNICIPALDEBT MARKETINROMANIA 3.1 Spurred by monetary and fiscal stabilization and rising expectations of EU convergence, the Romanian financial market has developed very rapidly over the last five years. The spread between the 12-year sovereign Eurobond and the 3 month Euribor declined from 420 basis points in December 2002 to 80 basis points in June 2007 (see Figure 3.1). Romania's sovereign credit rating reached investment grade in September 2005 (Standard & Poor's BBB - (stable)(foreign currency); BBB (stable)(domestic currency). Since then, Fitchupgraded Romania's long-term foreign currency Issuer Default Rating (IDR) to BBB in August 2006 and Moody's upgraded the country's foreign currency government bond rating to Baa3 inDecember 2006 in line with the country's EU accession. Figure3.1: Sovereign Eurobond-Euribor spread, 2002 June 2007 - 12-year Sovereign Eurobond vs. 3-Month Euribor -+Romania 2012, Yld Source: ME17 3.2 Inthis favorable context, the local government debt market has taken off rapidly, although from a very low base. Domestic currency loans by commercial banks to local governments increased from RON 3.6 million in 2001 to RON 1,399 million in 2006 (or US$498 million). They amountedto RON 704.7 million inthe first 9 months of 2007 (or US$ 287 million) (See Statistical Annex Table Al). Short-term loans (maturity less than 1 year) grew from RON 1.8 million in 2001 to RON 16.9 million in 2005, or 1.2 percent of the total. Loans with maturity longer than 1 year increased from RON 1.8 million to RON 1,393.4 million over the same interval, or 98.8 percent of the total. Among loans with maturity longer than 1 year, average maturity increased from 2.3 years in2001 to 4.1 years in2004, to 10.6 years in2005, to 14.2 years in2006 and to 16.8 years inthe first 9 months 20 Romania: Municioal Finance Policv Note of 2007. The longest maturity was 3 years in2001, 10 years in2004, and 25 years starting 2005. Among loans with maturity of less than 1 year, average spreads over BUBOR declined from 500 basis points in 2002 to 195 basis points in 2004. Among loans with maturity longer than 1 year, average spreads over BUBOR declined from 327 basis points in2002 to 224 basis points in2004, to 78 basis points in2006 andto 41 basispoints inthe first nine months of 2007 (See Figure 3.2). The reduction in spreads was accompaniedby significant spread compression across all local government categories, with spread variation dropping from 196 basis points in 2003 to 58 basis points in 2006 and 58 basis points inthe first ninemonths of 2007. Figure 3.2: Local government loans average spread and maturity, 2001-September 2007 Loans average spread and average maturity 3.50% 250 3.00% 200 2.50% -iAmragespreadow - Bubor (%) 2.00% 150 +Amrage maturity (months) 1.50% 100 1.00% 50 0.50% 0.00% 0 2001 2002 2003 2004 2005 2006 Sep47 Source: MEF 3.3 Domestic currency bonds issuance by local governments increased from RON 2.3 rnlnin2001 to RON 46.5 in2003, declining to RON 36.7 mlnin2004 (or US$ 11.2 rnln). It amounted to RON 38.8 mlnin 2005 (or US$ 12.9 mln) and RON 133.0 mln inthe first ninemonths of 2007 (or US$ 40.3 mln) (See Statistical Annex Table A2).Average size of bond issues was RON 6.5 Mln in 2005; it amounted to RON 22.1 mln in the first nine months of 2007. Average maturity increased from 2.5 years in 2001 to 3.3 years in 2004, 6.7 years in 2005, 16.5 years in 2006 and to 19 years in the firs nine months of 2007. The longest maturity was 3.5 years in2001, 6 years in 2004 and 20 years in2005,2006 and the first nine months of 2007. Average spreads over Bubor were negative until 2003. The average spread over Bubor was 69 bp in 2004, declining to 32 bps in 2005 and increasing to 76 bps in 2006. Inthe first nine months of 2007 the average spread over Bubor was 11 bps. 3.4 Over the period 2001-September 2007, 15 municipalities larger than 100,000 inhabitants (about 62 percent of the group) and 47 municipalities between 13,000 and 21 Romania: Municiual Finance Policv Note 100,000 inhabitants (about 63 percent o fthe group) had access to loanshonds. By contrast, only about 14.5 percent of towns and communes (with less than 13,000 inhabitants) had access to loanshonds. 22 County Councils (or about 52 percent o f the group) had accessed the loanshonds market. 3.5 The geographical distribution o f municipal loans has been spreading progressively toward medium-size cities and, to a lesser extent, small cities and communes. In2005, the geographical distribution o f domestic currency loans with maturity longer than 1 year was 41.4 percent to Bucharest, 41.8 percent to municipalities larger than 100,000 inhabitants (including County Councils), 11.3 percent to municipalities smaller than 100,000 inhabitants, and 5.5 percent to small cities and communes. In 2006 the geographical distribution o f domestic currency loans with maturity longer than 1 year was 22.2 percent to Bucharest, 53 percent to municipalities larger than 100,000 inhabitants (including County Councils), 15.5 percent to municipalities smaller than 100,000 inhabitants, and 9.3 percent to small cities and communes. In the first nine months o f 2007 the geographical distribution o f domestic currency loans with maturity longer than 1 year was 69.5 percent to municipalities larger than 100,000 inhabitants (including County Councils), 21.2 percent to municipalities smaller than 100,000 inhabitants, and 9.3 percent to small cities and communes. 3.6 In 2005, the geographical distribution o f domestic currency bond issuance was 52 percent for municipalities larger than 100,000 inhabitants (including County Councils), 37 percent for municipalities smaller than 100,000 inhabitants, and 11 percent for cities and communes. In the first nine months o f 2007 the distribution was 94 percent for municipalities larger than 1OOK inhabitants (including County Councils) and 6 percent for municipalities smaller than 1OOK inhabitants. 3.7 Borrowing by local utility companies on the domestic market has been insignificant to date. Over the past 6 years, IFIs and foreign commercial banks lent to Romanian municipalities at the rate o f Euro 150 million a year, with an average loan size o f Euro 14 million. Average loan maturities ranged from 13 to 25 years over the period. Spreads over Euribor average was ranging from 35 basis points to 398 basis points. External lending was highly concentrated on Bucharest and on cities larger than 100,000 inhabitants, which received more than 88 percent o f external loan value to local governments over the period (See Technical Annex Table A3). 3.8 InMay 2005, the municipality of Bucharest obtained an S&P rating of BB inboth foreign and domestic currency. In May 2005, the city's rating was upgraded to BB+ (stable) in foreign and domestic currency, i.e. one notch below the sovereign for foreign currency rating, and two notches below the sovereign for domestic currency rating (see above). InJune 2005, Bucharest placed a fixed coupon Eurobond with a spread at issuance o f216 basis points above Euribor with a 10 year maturity. 3.9 The spread compression observed on the domestic local government debt market over the last two years has been driven by several, mutually reinforcing factors. First, excess liquidity in the domestic banking system, conservatively estimated by market participants at Euro 5-6 billion in 2005. Second, the pricing behavior o f the (then State- 22 Romania: Municipal Finance Policv Note owned) BCR as the dominant market player. And third, distortions inrisk pricing resulting from deficiencies in the legal and regulatory framework for local government borrowing (see Section 3.2 below). Some o f these factors are already changing. Starting inNovember 2005, NBR introduced measures to sterilize excess liquidity inthe domestic bankingsector. Excess liquidity in the domestic banking sector was drained largely via variable-rate deposit auctions and also through issuance o f certificates o f deposit. The stock - daily average - o f both deposits taken and certificates o f deposit issued by NBR have declined from about Euro 3.3 billion in 2006 to about Euro 2.8 billion by September 2007 and average spreads on the domestic local government debt market started to widen in 2006. And the privatization of BCR in October 2006 resulted inthe emergence of a sub-national debt market largely dominated by private players. 3.10 The recent entry o f Romania into the EU single financial market creates both opportunities and challenges for the future development o f the sub-national debt market. On the one hand, as experienced by the recent EU accession countries o f Central Europe, competition in the market will continue to increase as European and international banks and institutional investors increase their exposure to the Romanian market, both through expansion o f activities o f subsidiaries and branches already present at the time o f accession and through new entry. This will further diversify the range of financial products available for Romanian sub-national entities and may put further downward pressure on spreads. On the other hand, Romanian sub-national entities, both local governments and municipal corporations, will face increased competition from similar entities in all EU-27 member countries to secure a share o f bank lending and institutional investor investments in the context o f international risk management strategies that are conceived and deployed at the level o f the EUsingle market. These opportunities and challenges will further intensify as a result o f the entry into force o f the Markets inFinancial Instruments Directive (MiFID) on November 1, 2007 and as a result o f Romania's future entry into the Euro-zone. Meeting them will be crucial for Romanian sub-national entities to be able to mobilize the financial resources required to improve local service delivery for the population and to meet the standards o f the acquis communitaire inthe context o fthe EUsingle market. 3.11 To seize these opportunities and meet these challenges, the Government needs to focus on two main priorities. First, to develop and implement a modern legal and regulatory framework for local government borrowing that removes distortions in risk pricingon the market and allows the emergence o f a level and transparent playing field on which Romanian sub-national entities can compete for bank and institutional investor portfolio allocations in the context o f the EU single market. And second, to design and implement a coherent strategy to increase the access o f sub-national entities to the sub- national debt market in function o f their risk profile. REFORMING THE SUB-NATIONAL DEBT MARKET LEGAL AND REGULATORY FR4MEWORK 3.12 The legal and regulatory framework for local government borrowing suffers from several deficiencies pertaining to (i)control o f local government borrowing; (ii)local government own-revenue guarantees; (iii) short-term Treasury loans; (iv) local government bankruptcy; (v) risk fund for local governments; (vi) risk-weighting for local government 23 Romania: Municival Finance Policv Note debt in the calculation o f banks capital adequacy ratio; and (vii) enforcement o f public procurement law on access to bank borrowing. In addition, the development of the market i s hampered by the high regulatory cost o f bond issuance. Addressing these deficiencies constitutes the first priority for the Government to enable the development o f the sub- national debt market inthe context o fthe EUsingle market. Control of local government borrowing 3.13 Under Law 273/2006 on Local Public Finance (LLPF), control o f local government borrowing consists o f two components: (i)ex ante authorization o f local government borrowing and guarantees by the MEF on a case by case basis; and (ii) a prudential limit on the local government debt service set at 30 percent of own revenues22.Inaddition, the MEF may issue case-by-case derogations from the debt service ceiling through Emergency Ordinances. The City o f Bucharest obtained such derogation for the issuance o f its Eurobond in June 2005 through Emergency Ordinance 225/2005, approved by Law 44/2005. 3.14 Under Government decision 9/2007 establishing the Local Borrowing Authorization Commission, the application package to be submitted by local governments to the Commission includes, in addition to basic information on the borrowing decision by the local government, the loan or guarantee agreement and current and past budget execution, detailed financial scenarios o f the local government debt service during the period o f the loadguarantee. This de facto places the MEF in the position o f assessingthe creditworthiness o f local governments for each new borrowing or guarantee, a fbnction which should be left to private banks, bond underwriters and credit rating agencies in the context of a market economy. 3.15 By placing the MEF in the position of assessing the creditworthiness o f local governments for each new borrowing or guarantee, the LLPF puts unnecessary political pressure on the MEF to bail-out a local government in case o f default on a debt obligation that it has itself approved (i.e. implicit guarantee), thereby generating moral hazard. This i s krther magnified by the MEF's authority to issue case-by-case derogations to debt service ceilings for local governments. To remove this major source o fmoral hazard, it i s advisable to gradually phase-out MEF ex ante control o f local government borrowing and replace centralized screening o f local government creditworthiness by market discipline, intandem with the introduction o fthe local government bankruptcy framework and with the phasing- out o f Treasury loans (see below): 3.16 Duringa first phase, (Phase One), the authorizationfor local government borrowing by the MEF would be automatic unless the MEF formally notifies the local government of its decision to deny the authorization within 15 working days o f the date o f submission of the dossier o f registration. The dossier of registration would be simplified and contain information on the local government decision to borrow, the loan agreement or bond prospectus, and current and past budget execution. The LLPF would indicate that the MEF 22The loans contractedguaranteed bythe local authorities to pre-finance andor co-finance projects which benefit ofnon-reimbursable pre-accession and post-accession EUfunds are exempted from this provision (Emergency Ordinance 46/June 2007). 24 Romania: Municival Finance Policv Note decision to deny authorization i s based solely on material flaws in the registration dossier or its failure to satisfy the prudential limit on the local government debt service and would be published on the MEF website upon its communication to the local government. The LLPF would also indicate that the local government has the right to appeal this decision. Transparent procedures for appeal o f the decision would be spelled out in a separate regulation, including the modalities for publication o f the request for appeal and o f the appeal decision on the MEF's website. The LLPF would also explicitly prohibit case-by- case derogations o f debt service ceilings for local governments by the MEF. 3.17 During a second phase (Phase Two), the authorization o f local government borrowing by the MEF would be entirely automatic. The MEF would exercise ex post control o f local government borrowing through a quarterly budget execution review process. If a local government exceeds its debt service limit, the MEF would issue a decision prohibiting any new net borrowing by the local government until its budget i s brought back into compliance with the prudential ratio. 3.18 During a third phase (Phase Three), MEF control would be exercised ex post through the regular yearly budget execution review process. As in Phase Two, if a local government exceeds its debt service limit, the MEF would issue a decision prohibiting any new net borrowing by the local government until its budget i s brought back into compliance with the prudential ceiling. 3.19 Inthe longer-term, at the latest by the time of integration into the Euro-zone, local governments that have obtained at least two global scale, local currency credit ratings by established international rating agencies would be subject to more a relaxed debt service limit, givingmarket participants ample room to make lending decisions based on the local government credit quality. The MEF would continue to exercise its yearly ex post control over local governments as described inPhaseThree. 3.20 In addition, it is advisable that the LLPF stipulate that that ex ante approval be required for local government borrowings in foreign currency (Le. non-Euro following entry in the Euro-zone) and for local government borrowings or guarantees requiring Government sovereign guarantee or counter-guarantee. Local government own-revenue guarantees 3.21 Article 63 o f the LLPF allows local government debt to be guaranteed by its own revenue-including Government transfers -land gives precedence to such debt over all other claims against the local governmentz3.Some financial institutions consider that the own-revenue guarantee issued by a local government i s exercisable with the Treasury. Therefore they consider this guarantee as good as a government guarantee and explicitly 23Art. 63 reads:"( 1) The loans contracted by the administrative-temtorial units, as well as those contractedby the companies andpublic services under their subordination, may beguaranteed with their own revenues as defined inart. 5, paragraph (I), letter a); (2) Any guaranteewith revenues shall become effectiveon the datethe guaranteeis granted; the revenuessecuring the guaranteethat are collectedby the local authority shall be subject to the provisions of the guamntee agreement, and the requirements of that agreement shall be given priority over any thirdparty request to the localpublic administration authority, regardless of whether or not the third party is aware of the guarantee agreement." Art. 5 reads: "( 1) local budget revenuesare be composed of: (a) own revenuesfrom: taxes, fees, contributions, other payments, other revenuesand allocated shares from the incometaxes; (b) amounts allocated from certain revenues o fthe statebudget; (c) subsidies from the statebudget and from other budgets; (d) donations and sponsorships. 25 Romania: Municipal Finance Policy Note mention this guarantee in bond prospectuses to investors. On the other hand, Law 288/2002 stipulates that the State Treasury can only execute payments when ordered by budget managers o f public institutions. This would appear to give local governments discretion to honor their guarantees or not. This ambiguity has been addressed by Law 110/2007, which stipulates (Art.3) that if a public institution fails to fulfill its payment obligations within 6 months from the date it receives an enforcement order, the creditor may request enforcement according to the Civil Procedure Code and/or other applicable legal provisions. The credit release authorities (in this case, the mayors o f local governments/president o f County Council) have the obligation to order all steps, including transfers o f budgetary resources, necessary to ensure, both in their budgets and in the budgets o f institutions under their supervision, the amounts necessary to pay the amounts set forth by the enforcement order. If the local authority fails to comply, the Treasury, acting on instructions from the court, may transfer the funds directly from the municipality's account to the creditor. It i s not yet clear, however, that the market perceives the distinction between these provisions and a central government guarantee. 3.22 Further changes in legislation are under consideration. An Emergency Ordinance 64/200724on Public Debt was published in the Official Gazette on June 2007. The EO 64/2007 considers establishing the general framework and principles o f the public debt management dealing with the government public debt. In this context, the EO 64/2007 proposes to abrogate, among others, the Law 313/2004 on Public Debt, with subsequent amendments, and some provisions concerning offences and punishments o f the Law 27312006 on Local Public Finance. The Emergency Ordinance was rejected by the Senate in October 2007 and is now (November 2007) under discussion in the Chamber o f Deputies. It is important that any new legislation in this field make it clear that local government debt-whether revenue guaranteed or not-carries no implicit Government backing. Short-term Treasury loans 3.23 The LLPF allows the MEF to extend short-term Treasury loans to local governments. Treasury loans to local governments create three fundamental problems. First, they put the MEF in the role o f credit allocation and pricing for local governments. Second, international experience with Treasury and other Government agency loan facilities or with State-owned municipal funds shows that such facilities or funds are open to political pressure, often resulting in discretionary decisions and generating a culture o f non-repayment. And third, Treasury loans constitute a ready-made instrument to bail out local governments in case o f default. As a result, Treasury loans soften the budget constraint for local governments andbreedmoral hazard on the sub-national debt market. 3.24 It is advisable to progressivelyphase-out the Treasury loan instrument, starting with the largest cities. These cities could use the provision o f the LLPF allowing local governments to open a bank account linked with a loan from a private bank and open overdraft facilities with private banks to manage their short-term liquidity needs. 26 Romania: Municipal Finance Policv Note Localgovernment bankruptcy framework 3.25 Articles 74 and 75 o f the LLPF provide a sound legal framework for local government bankruptcy. A draft law (which, when promulgated, will specify the procedure in applying the provisions of Articles 74 and 75) is currently being prepared by the Ministryo f Interior and Administration Reform and the Ministryo f Economy and Finance. The current (2007) version o f the draft law is quite comprehensive, specifying the criteria to be used indeclaring a state o f financial crisis and its termination, the content o f financial recovery plans, the participants in the process (including the syndic judge, the creditors' committee, and the judicial administrator) and sanctions to be imposed. Certain issues remain to be clarified, however, including the definition o f `essential municipal services' and the conditions under which loans from the State Treasury would be made to local government undergoing a plano f financial or insolvency recovery. Article 93 o f the current draft permits the Ministry o f Finance to authorize the Treasury to make loans for the implementation o f insolvency recovery plans. It also permits the Government to provide support from the Government reserve fund. Both forms o f assistance should be available only under highly restricted conditions, in order the appearance o f a Government bailout and the moral hazardthis would create. Riskfundfor localgovernments 3.26 The LLPF provides for the establishment o f a Risk Fundto cover the financial risks that derive from the guarantees by local government units for loans contracted by municipal corporations. The RiskFundi s an off-budget itemthat contains the commissions and other fees paid by the beneficiaries o f loan guarantees, and from which payments are made in case o f guarantee calls. If such payments are made, the amounts recovered from the defaulted entities are used to replenish the Risk Fund. It would be advisable that the methodological norms to be issued in the application o f LLPF specify the modalities o f implementation o f the Risk Fundby local governments, paralleling those being developed at the level o f the MEF Risk Fund. Riskweighting localgovernment debt incalculatingbank capital adequacyratio 3.27 Insetting capital adequacy ratios for loans to local governments, National Bank of Romania (NBR) regulations require banks to use a risk-weighting o f 50 percent for loans to jurisdictions with no credit rating and a variable risk-weight to jurisdictions that have been rated. 25Although this i s considerably higher than the previous 20 percent risk weighting, it still signals that lending to local governments carries modest risk and therefore contributes to moral hazard in the market. Consistent with the legal and regulatory revisions proposed inthis Policy Note, it would be advisable for NBR to raise the risk weight to 100percent for loans to local governments with no credit rating. While this could increase the cost o f borrowing for small jurisdictions (as they may be unable to afford a credit rating) the 100 percent weight better reflects the risk o f lending to such entities, particularly as the option ofbankruptcy (through the insolvency procedure described earlier) exists. 25Regulation NBR-NSC No. 14/19/2006on credit risk treatment using the standardized approach, for credit institutions and investment firms 27 Romania: Municipal Finance Policv Note Enforcement of public procurement law on access to bank borrowing 3.28 Local government/municipal corporation access to bank borrowing is subject to the Public Procurement Law. These bodies are required to obtain a minimum o f three tender offers for each loan. This procedure i s sound and should be enforced without exceptions. High regulatory cost of bondissuance 3.29 A key constraint cited by market participants is the high regulatory cost of bond issuance inRomania compared with the international benchmarks. For example, the cost o f a 50 million bond listing on the Vienna Stock Exchange i s 3,000 and the cost with the regulatory authority i s 800, compared to a regulatory cost o f a bond of similar size in Romania o f50,000 (0.1 percent Security Exchange Commission fee plus a maximum 0.02 percent Bucharest Stock Exchange fee when the distribution i s through BSE). It would be advisable to align the regulatory costs o f bond issuance in Romania with those observed in EU member countries in order to enable domestic issuers to compete on a level playing field with their EUcompetitors. IMPROVINGSUB-NATIONAL ENTITIES'ACCESS TO THE SUB-NATIONAL DEBT MARKET 3.30 As a second priority, the Government needs to design and implement a coherent strategy to improve access by sub-national entities, both local governments and municipal corporations, to the sub-national debt market in the context o f the EU single market. This strategy should consist o f a range o f technical assistance and financial support instruments carefully modulatedbased on the risk profiles o f particular sub-national entities inRomania (see Figure 3.3 below). Figure 3.3 Technical assistance and financing instruments TechnicalAssistance: FinancialSupport: .Capacityandpotjcy framework Leveragelocalprivatefinancjalmarkets -Upstreammarketdevelopment -Use of guarantees and derivatrves Proiectfacilitation A Loarts{localcurrency),occasionallyUS5 Tier 1: hhrtretAccess onOwnCredit Improvefiscal responsrbility, financht managementand eorporilte governanceto reamnnancaai Tier2: MarketAccesswi.thCredit Support vlablllty andmarketa c c m Tier3: Audited Financiais fier4: LimitedFinancial Transparency Source. WorldBank, Sub-nationalDevelopment Program, 2006 28 Romania: Municipal FinancePolicv Note (i)Lowrisksub-nationalentities(Tier 1) 3.3 1 At the top o fthe pyramidare low-risk sub-national entities that can accessthe market on their own credit to finance their infrastructure investments, including financing the counterpart funds for EU cohesion and structural funds. InRomania, this market segment comprises a small group o f about 10to 15 large municipalities that are one or two notches below the sovereign rating, based on their credit rating by an international rating agency or on their internal risk assessmentby a domestic bank(s). These municipalities can access the domestic market on their own at maturities exceeding 15 years and at spreads below 50 basis points without sovereign guarantee. These municipalities have therefore graduated from financial support from International Financial Institutions (IFIs), as the cost o f credit enhancement that could beprovided to them by IFIs i s higher than the benefit o f this enhancement interms o fspreadreduction andmaturity extension. Inpractice, some o f these cities still opt to draw on IF1resources although that i s expected to change over time. (ii)Medium-risk sub-national entities(Tier 2) 3.32 Next i s a second tier group consisting o f sub-national entities that can still access the market but with higher spreads and shorter maturities that are not suitable for the financing o f infrastructure investments. This is due to a variety of conditions affecting their riskprofile, including size, ownrevenue base, or debt sustainability. Inparticular, many sub-national entities inthis group may be too small to issue a bond o f a size reachingthe minimumthresholdo fliquidity on the domestic market. InRomania, this second tier group comprises the vast majority o f secondary municipalities and their local utility companies, as well as a few towns and communes. 3.33 This second group could benefit from a dual package o f support including both technical assistance and financial support. Technical assistance 3.34 The package o f technical assistance would aim to strengthen the fiscal and financial management as well as the quality o f governance o f the sub-national entities in the group with the objective to enable them to eventuallyjoin the first tier and access the market on their own credit. 3.35 This package o f technical assistance could aim to: (i)Develop the capacity of sub-national entities to prepare investment programs and projects, including thorough economic and financial appraisal and assessment o f environmental and social dimensions and mitigation o f their investments; (ii)Improve the performance o f local utilities, possibly through PPPs, in which case it would include developing the capacity of municipalities andmunicipal corporations to 29 Romania: Municiual Finance Policv Note structure and negotiate Public-Private Partnerships (PPPs) with private investors/operators26; (iii) municipalitiesdevelopandadministersocialprotection programsforlow- Help income households, so as to improve their ability to raise tariffs towards cost-recovery levels ina manner that i s socially and politically acceptable; and (iv) Develop the capacity o fmunicipalities and municipal corporations to prepare detailed dossiers for international credit rating agencies with the objective of obtaining a local or foreign currency, global scale credit rating. Financial support 3.36 As sub-national entities in the group strengthen their fiscal and financial management capacity, including their capacity to structure financing packages for loans or bond issuance, various forms o f financial support could be developed to improve their conditions o f access to the market. Inparticular, a Partial Credit Guarantee Facility (PCGF) could be developed, taking as a model similar facilities that have been successfully implemented to develop the secondary mortgage market in several emerging market economies, for example in Colombia. The possible structure o f such a Facility for sub- national debt obligations i s presented inFigure 3.4 below. ~~ ~~ ~ ~~~~ ~ ~~ Figure 3.4: Partial credit guarantee facility for sub-national debt obligations (SNOs) Private sponsor I *`Thiscomponent would cover the full range o f PPP transactions including management contracts, leases, BOOS,BOTS,concessions and divestitures. I t would apply bothto traditional localutility companies, andto Municipal Services Companies (MSCs) that may be established to undertake and manage investments in other sectors, such as road maintenance and the social sectors (See Annex 111.2: UK Private Finance Initiative (PFI) model). 30 Romania: Municipal FinancePolicv Note 3.37 The adoption o f the Securitization Law and o f related secondary legislation in2006 provides the foundation for structuring the proposed Facility on the basis o f a Special Purpose Vehicle (SPV) registered inRomania. The SPV would be established and managed by a private sponsor as a securitization company or trust with compartments. On the asset side, the SPV could hold a portfolio o f municipal or municipal utility corporations' debt obligations (SNOs). These could be loans or bonds, including general obligation (GO) bonds issued by municipalities and revenue bonds issued by municipal corporations. The liabilities o f the SPV could consist o f senior and subordinated debt tranches and an equity tranche. The cash flows from income and principal could be distributed among the various debt tranches and the equity tranche according to pre-set rules. The SPV would be externally credit-enhanced through a partial credit guarantee for SPV bonds from an IFI. In addition, the IF1 could also provide a liquidity facility to the SPV to manage cash-flow mismatches. The structure o f the partial credit guarantee for SPV bonds could be defined on the basis o f market demand. Each SPV would be ratedby international agencies. 3.38 The structure would be strictly market-driven and sponsored by private investors. The SPV manager could build a first compartment based on available sub-national debt deal flow, portfolio diversification criteria, and investors' appetite. Subsequent compartments could have different underlyingassets and portfolio risk profiles to adapt to the evolving supply of debt obligations by municipalities and municipal corporations and investors' appetites. 3-39 Access to the securitization vehicle by municipalities and municipal corporations would be subject to a number o f criteria. Inthe case o f municipalities, these would include (i)pastbudgetperformance; (ii) ofinvestmentprogram; (iii) quality medium-term budget scenarios/stress tests; (iv) quality o f municipal governance (budget management, transparency, disclosure). Inthe case o f municipal corporations, criteria would include: (i) quality o f contractual arrangements between the municipality and the municipal corporation; (ii) quality o f contractual arrangement between private investor/operator and the municipal corporation in case o f PPP; (iii) financial performance; (iv) quality o f past investment project; (v) medium-term financial scenarios and stress tests; and (vi) quality o f governance (operational and financial management; transparency; disclosure). 3.40 A simplified financial simulation o fthe proposed PCGF is presented inAnnex 111. High-risk municipalities/municipalcorporations (Tiers 3 and 4) 3.41 High-risk municipalities and municipal corporations do not have access to the market, even with credit enhancement. Because they are not creditworthy, these municipalities and municipal corporations should not borrow from any source (including on-lending from the central Government). 3.42 For this group, support would focus essentially on technical assistance to strengthen fiscal and financial management and corporate governance, up to the point where the entities are able to produce audited financial statements. A particular emphasis would be placed on developing the capacity o f small cities and communes to form Inter-Municipal 31 Romania: Municipal Finance Policv Note Undertaking (IMUs) (inter-communales) with the objective to reach economies o f scale for the provision o f local services whenever economicallyjustified. 3.43 Inparallel, conditional capital grants may bejustified to fund local investments of highpriorityfrom an economic, social and/or environmentalperspective, includingfunding the domestic counterpart o f EU funds. A possible approach could be to establish a competitive capital grant system under which sub-national entities belonging to this group would compete for a limited envelope o f grants based on their score across a number of access criteria. Moral hazard could be mitigated by requiring that repeat grants to the same local government or municipal corporations would be subject to a pre-set improvement in their multi-criteria score, and by limitingthe number o f repeat grants. As a result, high-risk local governments and municipal corporations would have a built-inincentive to improve the quality o f their management across a broad range o f dimensions and thereby the possibility of graduating to Tier 2 and accessing the market with external credit support. 32 Romania: Municipal Finance Policv Note Romania: MunicipalFinancePolicyNote ANNEXES Annex I Selected County and Local Government Functions Annex I1 Utility Provision and EUFinancingArrangements Annex I11 Local Government Debt Market and Access to FinancialMarkets 33 Romania: Municiual Finance Policv Note Annex I ns Policy Financing Service delivery Central I Regional operator County government eovernment Countv government County roads Central County government County government Transport Private operators andlor county government Airports (civil airports) Central County government. County government government County public service for Central County government County government personal data records28 government Central government Maintenance o fpublic Central IIIICounty government County government health units o f county De-concentrated services of interest central government Special education County government The de-concentrated unitsofthe central government Centers for children with Central County government County government disabilities, Services for government The Ministry o fPublic abused and neglected Finance children Care and assistancecenters Central County government County government for persons with handicap government The Ministry o fPublic Finance Centers for recovery and Central County government County government psychiatric rehabilitation government The Ministry o f Public Finance Cashbenefits for blind Central The Ministry o f Labor, Social County government for persons and their escorts government Solidarity and Family identification o f eligibility De-concentrated units o f the central government for payment Food allowance for Central County government County government institutionalized children government The Ministry o fPublic with HIV/SIDA authority Finance Art and Vocational School Central County government County government government Art andVocational School Art and Vocational School I 27This function is assigned to this administrative levelonly when a regional operator is created andplaced under the county council. 28The service was set up through the merger ofthe civil status service, already subordinated to the local government, and the county office for personal data records, previously subordinated to the Ministryo f Administration and Interior. 34 Romania: Municiual Finance Policv Note County guard service Central County government County government government County guard service Public service Policy Financing Service delivery hnction Annex Table 1.2 Selected Local Government Functions Policy Financing Service delivery Emergency situations at the Central Local government Local government local level government Water supply and water Central Water Operator Local government sewage government Local government District heating Central Local government Local government government Ministry o f Public Finance The district heating operator The district heating operator Waste management Central Local government Local government government The operator ofwaste The operator of waste management service management service Local public transport Central Local government Local government government The operator o f localpublic The operator of local public transport service transport service Public lighting Central Local government Local government government Road and street network IICentral II Local -government for the Local government for the street government street network o f local network o f local interest, county interest, Central government government for commune and for commune and national county roads, central roads government, for national roads Housing Central Local government Local government government De-concentrated units Community public services Central Public community service for Local government for the service for personal data records government personal data record delivery, County Council andthe Local government central government for Central government methodological control Community police Central Local government Local government government Social-medical assistance Central Local government, the socio- Local government, the social services government medical assistance unit, the medical assistanceunit, for National House o f Health delivering the public service Insurance, Central government Maintenance o f public Central Local government Local government health units o f local interest government MinistryofHealth Ministry o f Health, through its de-concentrated services Daynursery Central Local government Local government government MinistryofPublic Finance Preschool education Central Local government, Central Local government Government government De-concentrated services o f MinistryofEducationand Research 35 Romania: Municipal Finance Policv Note Annex able 1.2 Selec ions, cont'd Primary and secondary Central Local government Local government, Teachers' education Government Central government board, the Administration Board, De-concentrated services of central government High school (secondary) Central Local government County government and insome education government Central government cases larger local government, Teachers' board and the Administration Board De-concentrated services o f the central government Shelters for the elderly Central The shelter for elderly The localgovernment government persons, Local government, Central government The National House for Social Health Insurance Newborn child allowance Central MinistryofLabour, Social Local government government Solidaritv and Familv Emergency centres for the Central Local government Local government victims o f domestic government violence Social aid (minimum Central Local government 29 Local government guaranteed income) government MinistryofPublic Finance Cultural centre Central Local government Local government government Cultural center Cultural center 29The sector legislation inforce assigns this competence exclusively to the local government (communes and towns), but inpractice 80% o f the hnds used for this purpose come from the state budget through allocated sums from some statebudget revenues (earmarked transfers). 36 Romania: Municipal FinancePolicv Note ANNEX I1 Utility Provisionand EUFinancinpArrangements CentralGovernmentSupportfor EnvironmentalInvestments The nature o f the water and wastewater business i s such that it requires public support for investments. In financial terms, compared to the other infrastructure sectors, the investment needs inthe water sector are highest to generate unit o f revenue3' (Table 1). The table below shows that it would take a much longer time to recover the investment from the annual revenue in the water supply and sewerage sector than in the other infrastructure sectors. As a result, private investors will be cautious to invest, especially if tariffs are determined in a subjective and politically driven manner. Sector Required Assetdoperating Revenues Water Supply and Sewerage 10 Toll Roads 7 Electric Utilities 4 Telecommunication Utilities 3 In economic terms, the involvement o f the public sector is often justified since investments in the water sector generate positive externalities such as better environment, reduced incidence o f water borne diseases, or increased tourism activity, especially in coastal areas where the treatment o f wastewater i s highly valued. Similar positive externalities exist for the solid waste management sector. In addition, for Romania, the economic gains related to EUAccession will be large. Thus, the use of public resources to meet the country's commitment towards the EUi sjustified. All European Governments have provided support to the development o f their own domestic water and wastewater sectors (selected examples shown in Table 2) and for the solid waste management sectors. Significant public resources have been utilized for the 30Efficient, Sustainable Service for All An Evaluation of the World Bank Assistance to the Water Supply - and Sanitation Sector', Operations Evaluation Department, The World Bank, September 1, 2002 37 Romania: Municipal Finance Policv Note development o f the water and wastewater sector as the assets are largely in the public domain. Even inthe United Kingdom, where the water and wastewater assets were sold to the private sector, the public sector took on the debt prior to privatization and provided tax incentives to the private operators. In summary, there i s an element o f investment subsidy inall EUcountries. InRomania, compared to Western European countries, the per capita cost for the infrastructure upgrading i s higher, and the tariffs and household incomes are lower. Thus, the proposed expenditure framework will have to take this into account while estimating the level o f sovereign support for local infrastructure development. Currently, such policies are not in place but the Government's draft Municipal Services Strategy proposes grant support for municipalities and communes either through EU grants or State budget. The level o f State budget support for EU related investments are proposed as follows: a) urban area with population above 100,000 inhabitants: 50 percent; b) urban area with population below 100,000 inhabitants: 70 percent; and c) rural area: 85 percent. Before such a policy i s put inplace the criteria for State support should be made clear and whether such support i s fiscally affordable should be determined. Table 2 I Examples of Government Support inWaterMastewater Sector Country Per Capita Average Investment Unaccounted Investment Equivalent Subsidy for Water (/year) Tariff ("/.I ("/.I (/m3) Austria 128 2.41 24% 8% England 98 2.43 18% 29% GreenDowry France 94 2.44 15% 25% Germany 113 3.93 3% inWest; 15% inEast 8% Romania 385 0.60 To be determined Around 50% In Western Europe, various types of State support have been provided for the development o f the water and wastewater sector and strengthening the solid waste management sector. Some o f them are listed below and the model chosen by Romania would have to be reflected inthe expenditure framework. No operating subsidies should be provided but the central government assistance may be provided for investments, if justified and fiscally affordable: 0 Direct budgetary support for investments; Assumption o f utility debt by the public sector prior to privatization; 0 Tax advantages to utilities that invest innetwork expansion or upgrading; Debt service o f utilities partly serviced by the State; 0 Sovereign guarantees o f loans intended for sector development; 0 Tax advantages to investors that purchase municipal bonds for investments. 38 Romania: Municipal Finance Policv Note ANNEX I11 Local Government Debt Market and Access to Financial Markets SPV structurefor low to mediumrisk municipalitiesand municipalcorporations Benefts and drawbacks of SPVstructure 1. The benefits o f structuring a SPV are significant, given the underdevelopment o f the Romanianmoney and capital markets. These benefits would include, among others: Possibility o f raising financing in the domestic market, and especially in domestic currency; Improved market access for low to medium risk municipalities and municipal corporations, thus promoting their names and possibly graduating to stand-alone borrowers and bond issuers over the medium term; High degree of flexibility, both on the investment and funding side of the SPV balance sheet. The SPV could package different forms o f obligations, thus better meeting the specific needs in terms o f financing, maturity and other specific terms o f municipalities and municipal corporations. At the same time, the SPV could issue bonds, borrow directly from banks and other investment companies in the form o f loans, lines o f credit, guarantees, bridge loans, etc.; Ability o f SPV to buy small sized obligations which would not under normal circumstances access the capital and money market, with the exception o f bank loans, and to package them for investors. Furthermore, the SPV would necessarily be rated by an international rating agency to ensure proper transparency, management and governance arrangements. The rating would increase the SPV marketability to both local and foreign investors, and promote the names o f its final borrowers to market participants; Bankruptcy-remote structure, where SPV creditors are not directly connected to the final debtors, i.e. municipalities and municipal corporations. This enhances the capacity o f the SPV to manage financial distress and bankruptcy at the local level through assets liquidation and general assets management and work-out techniques. Eventually, assets management services could be outsourced to specialized assets management companies against servicing contracts based on success fees; and Conditioning o f access to SPV financing upon a number o f prerequisites, requirements and parameters applicable to both municipalities and municipal corporations. These would cover areas such as fiscal sustainability; financial 39 Romania: Municipal Finance Policv Note soundness and performance; quality o f the investment programs; leverage; legal, regulatory andjudicial consistency; transparency, disclosure and accountability, and local currency credit rating (global scale). 2. The drawbacks o f the SPV structure are related to the complexity o f the financial structuring and management activities. In particular, SPVs' drawbacks would include, among others: Appropriate sequencing in the composition and development o f the investment portfolios, the support investment programs o f the municipalities and municipal corporations, and the associated funding. In this regard, SPVs are sometimes established by usingbridge loans, which enable to build the investment portfolios before accessing the market for funding. Bridge loans would enable the manager to process all required documentation with the municipalities and municipal corporations, including performing the due diligence, preparing the prospectus, registeringthe pledges and processing the legal documentation, etc.; Management costs could become high, especially when investment portfolios are too complex and/or heterogeneous. Most commonly, SPVs are built on specific assets types or types o f borrowers, to enhance transparency and marketability and management efficiency; and 0 SPVs' margins are generally small, especially ina low interest environment. As a result, there might be a tendency inincreasingthe size o f the investment portfolios to decrease the weight o f fixed operating costs while accumulating resources to cover eventual losses. This would potentially affect credit policies and render the SPV highly sensitive to recovery rates and probabilities o f defaults, which are not easily measurable even in the most developed market (especially in the municipal and municipal corporation markets). Structuring an SPV in Romania: terms and requirements 3. Setting up a SPV in Romania would require a number o f institutional, market and operational conditions. The SPV could be set up as a trust under the following institutional and operational arrangements: 0 A FundManager, or Agent, who acts as organizer and manager o f the SPV for its start-up and daily operations. These include accounting; treasury; investment policies; marked-to-market pricing; payments and collection o f interests and installments on debt instruments; due diligence o f debt issuers to assess feasibility o f investment programs, fiscal sustainability, transparency and accountability; market communication and disclosure; etc. The Fund Manager should be, preferably, a local bank or investment company. An operational manual with strict requirements for eligibility, policies and guidelines, would be the basis to ensure transparency and governance. The FundManager should be, preferably, a local bank or investment company with a high degree of 40 Romania: Municbal FinancePolicv Note professionalism and know-how. The SPV manager would work in liaison between the market and the municipalities and municipal corporations, ensuring that the latter consistently meet the above mentioned requirements for accessing SPV funding; The SPV should be all RON on both sides o f the balance sheet, as to avoid currency risks; The overall rating of the investment portfolio should be slightly lower than the overall debt issued by the SPV itself. This to generate a credit spread making the SPV profitable and self-sustainable. The credit spread should be enhanced through either: a) liquidity back stop facilities, or credit lines, to enable the SPV to accumulate reserves and address mismatches between partial defaults o f municipalities and municipal corporations, and the payments o f the coupons o f the SPV bond and/or the debt servicing o f the SPV loans; b) a SPV bond, mainly a standard plain vanilla bond; c) equity, although in the case of Romania, a all-debt SPV would be the preferable option given low margins on the domestic debt market and d) a bridge loan, to enable the Fund Manager to buildthe portfolio before issuingbonds or other debt; In order to enhance the rating of the SPV, IFIs could provide a partial credit guarantee to the SPV itself to cover a portion o f the debt obligations o f the SPV itselfbeyond the realized recovery (as assumed, see below). Alternatively, IFIs could provide the liquidity back-stop facility to build the necessary liquidity reserves and address liquidity mismatches. The bridge loan, preferably, should be provided by the Fund Manager, to enhance ownership over the investment portfolio; The difficulty in assessingthe feasibility o f such structure is estimating the risk profile o f the investment portfolio, and especially the volatility o f the obligations in terms o f probability o f default, and the recovery rates associated with it. Given the absence of a developed domestic debt market in Romania, recovery rates and probability o f default could be estimated based on international experience. For the purposes o f this note, probabilities o f defaults were assumed ranging between 5 and 10 percent on a five years basis, and recovery rates between 25 and 35 percent. The latter were lagged by three years, given the need to finalize the recovery of the pledges. These rates were standardized given the uncertainty related to the structure o f the investment portfolio, which would vary on a strictly case-by-case basis; Spreads between investments were assumed again based on international experiences. This i s mainly due to the absence o f a developed domestic debt market, with spreads sometimes below benchmark for risky issues. In the following, we assumed an average duration o f the investment portfolio o f about 5 years, with spreads ranging between 150 and 250 basis points for instruments rated between single B and BB. There i s some consistency in these spreads, as 41 Romania: Municipal Finance Policv Note Bucharest has recently issued Eurobonds with 216 basis points over the Euribor for a ten years maturity bond (See Section 2.1 above); 0 Taxation i s assumed even for the whole structure at the flat rate o f 16 percent on capital gains; Recovery o f defaulted obligations, thus assets management activities, are serviced-out to specialized assets management companies on a success fee based contract, or 5 percent o f the recovered assets. As mentioned earlier, cash inflows from recoveries are lagged by three years, also to reflect (i)the impossibility to intercept revenues and bank accounts o f municipalities, and (ii) the need o f municipalities to make provisions in the finance laws for debt recoveries. The situation would obviously differ for municipal corporations, although the three years lag was assumed conservatively across the investment portfolio; Interest rates are assumed fixed on both sides o f the SPV balance sheet, apart from the liquidity back-stop facility and the bridge loan. This would create a floating rate, or maturity risk inthe balance sheet o f the SPV equal to the size o f the facility itself. This type o f risk i s generally manageable, given that there i s a strong asymmetry between the steepening and flattening o f the curve. The SPV would in fact be at risk in case o f a flattening curve, which i s generally correlated with improved market and credit conditions, which should conversely decrease the credit and default risks, thus increasing the SPV soundness and profitability. In all cases, it could e assumed that a portion o f the investment portfolio i s based on floating rates, e.g. loans, to perfectly hedge this exposure. SPVbase casescenario 4. The following table is a summary o f the simulations ran according to the above assumptions. The overall size o f the SPV i s US$ 200 million, which seems feasible given the size o f the Romanian municipal and municipal corporation sector. The simulation is based on projected cash flows for 20 years, although the average maturity o f the investment portfolio was assumed at 10 years to reflect the mix between loans and bonds o f the portfolio. As mentioned earlier, assumptions are based on international experience, given the limited development o f the Romanian debt market money, but conservative. 42 Romania: Municipal FinancePolicv Note Reserves Levels (minimum 5 percent) 10% Real Returnon Investment (RESERVES) 82.6% PV of Outstanding Balanceof LlquldltyFacility 16.51 43 Romania: Municipal Finance Policv Note SPV structurefor mediumto high-riskmunicipalitiesandmunicipalcorporations 1. The credit enhancement structure of these types o f municipalities and municipal corporations would not differ considerably from the previous case, although the existence o f the sovereign guarantee introduces a number o f strong assumptions into the model. First o f all, the guarantee was assumed at 100percent o fprincipal at maturity, and given that this would be a IF1 guarantee backed by the counter-guarantee o f the Government, the guaranteed instrument would be either the bond o f the SPV or the SPV itself. Inthis case, there would not be the need for accumulating reserves in the SPV, given that there i s no need to enhance its creditworthiness. By the same token, the SPV would not need large liquidityback stop facilities, given that between there would be short time lags between the defaults o f municipalities and municipal corporations and the pay-offs o f the guarantees, even if not accelerable. The SPV could in fact sell outright the pay-offs o f the guarantees to institutional investors at NPV and at discount price. In all cases, a rating by an international rating agency would be warranted, to better address market distortions and mis-pricing. 2. The structure o f the SPV would remain identical in terms o f assets and liabilities, with the aforementioned exception o fthe lower reserve requirements. The maturities o fthe investment portfolio and SPV bond would match, for simplicity purposes. To remain conservative, the probabilities of default and the recovery rates were assumed unchanged from the previous simulations. This not because o f the difficulty to correctly assess a portfolio backed by a Government guarantee, but because the more stringent the assumptions, the more feasible and profitable would become the structure. Under these assumptions, the normal distribution o f the probability o f default would be incorporated in the model, with the exception o f the tails, which are basically the default o f the sovereign debt. Municipalities and municipal corporations would have, most probably, a correlation o f 1to the default o f the Government. 3, Other assumptions related to operating costs, recovery service-fees, maturities o f the bonds and investment portfolios, will be maintained unchanged for simplicity purposes. Taxation will also be computed on the profits based on a flat 16 percent capital gain tax rate. Double taxation issues are not considered. The credit spreads will be instead slightly increased to reflect the higher risk o f the issuers, which should incorporate their risk into the debt servicing costs. 4. Operationally, these types o f SPV would still need a Fund Manager, possibly a private bank or institutional investor, to ensure maximum transparency, governance and efficiency. The operational manuals and guidelines would ensure the consistent application o f good practices in terms o f transparency and governance, and disclosure. Access conditions to these facilities would be based on budget management processes and disclosure requirements by the municipalities and municipal corporations, quality o f the multi-year investment program, fiscal and financial soundness, forward-looking debt sustainability simulationand stress-tests, and local currency credit rating. 44 Romania: Municbal Finance Policv Note Risk Fund management modalities 5. In case the government provides a counter-guarantee to an IF1 partial credit guarantee facility, the MEF establishes a Risk Fundthat i s structured so as to achieve two objectives (i)to reduce moral hazard by charging a Risk Fund fee to participating municipalities and municipal corporations and (ii) cover a first risk tranche as defined by to the MEF. In case counter-guarantee payouts resulting from local government or municipal corporation default exceed the Risk Fund coverage, the MEF steps into honor the counter- guarantee. Counter-guarantee pay-outs are recuperated through the local government or municipal corporationbankruptcy procedures. 6. The management structure o fthe Risk Fundis based on four separate functions: The MEF i s responsible for defining the risk and pricing parameters o f the Risk Fund and for supervising its implementation. Specifically, the MEF defines the risk tranches to be covered by the Risk Fund and by the government, respectively; Exim Bank i s responsible for scoring the municipal risk according to a methodology issued by MEF Executive Order; The MEF is responsible for defining the Risk Fund fee for each risk category giventhe risk covered by the Risk Fund; and A private financial institution selected competitively manages Risk Fund cash and assets for a fee within the parameters o f a management contract defined by the MEF. 45 Romania: Municinal Finance Policv Note Table A 1: Loansto local authorities (2001 September 2007) - - fix rate e 1year 42.98% 26.83% 21.62% 20.82% 19.14% > 1year 42.69% 26.34Yd23.00% - margin 19.52% 16.90% 10.37% 9.23% -- maturity over Bubor 1year 5.00% 3.97% 1.95% maturity > I year - 3.27Y 1.89% 2.24% 0.87% 0.78% 0.41% Sep-07 -Bucharest - Municipalities>lOO.OOO 1 - 96,358 66,344 569,413 310,000 inhabitants" 1,54c( 25,860 98,757 -- Municipalities<100.000inhabitants 13,000 575,512 742,099 490,052 160( 4,98C 38,475 25,363 155,379 217,759 149,568 Cities, Communes 130( 4951 16,887 21,177 76,259 129,382 65,088 I Average interest rate 46 Romania: Municiual Finance Policv Note Table A 1: Loansto local authorities (2001 September 2007), cont'd - 19.49% 8.75% 22.29% 21.53% 10.40% 9.46% 18.18% 17.58% 9.45% 9.04% Average margin over Bubor - Municipalities >lOO.OOO inhabitants" 1.91% -Bucharest --- Municipalities - 2.00% Municipalities >100.000inhabitants" 3.77% 1.43% <100.000inhabitants -- 0.00% 3.11% Cities, Communes - 3.39% *- 2004 most **-inincluding were SAPARDpre-financing loans County Councils 47 Romania: Municipal Finance Policv Note Table A 2: Municipalbondson domestic market (2001 September 2007) - 2001 2002 2003 2004 2005 2006 Sep-2007 Total amount (000, RON) 2,250 11,900 46,504 36,716 38,750 33,150 133,000 Total amount (000, $ equivalent) 774 3,600 14,007 11,249 12,948 11,801 40,309 Average margin over Bubor3M -0.65% -0.53% -0.53% 0.68% 0.32% 0.76% 0.11% Average size (000, RON) 750 1,700 3,577 4,079 6,458 5,525 22,166 Average maturity (months) 30 26 29 40 80 198 230 Longest maturity (months) 42 30 60 72 240 240 240 By status of borrower I 2001 I 2002 I 2003 I 2004 I 2005 I 2006 Sep-2007 Total amount f000. RON) I I I I I I I I I I I -Municipalities >IOO.OOO inhabitants* I 8,000 33,500 28,800 20,000 15,000 125,000 -Municipalities IOO. 000 inhabitants* 28 29 42 72 213 231 --Municipalities lOO.OOO inhahitanLC* I I -0.53% 1-0.67% 1I 0.87% I - I 0.79% 0.06% I -Municipalities lOO. 000 145,400 inhabitants - 90,3 14 18,520 69,677 147,213 165,000 Cities, CommuneslOO. 000 0.60% inhabitants 2.58% 3.75% 3.90% 0.95% 1.20% -Cities, Communes< 100.000 1.OO% inhabitants 3.98% 0.25% Source: MEF *) the Eurobonds issued by Bucharest are not included 49 Mapsection 22°E 24°E 26°E 28°E UKRAINEUKRAINE ROMANIA To To Uzhhorod Uzhhorod To To Ivano-Frankivs'kIvano-Frankivs'k SELECTED CITIES AND TOWNS COUNTY (JUDET) CAPITALS To To NATIONAL CAPITAL ROMANIA BaltiBalti 48°N BOTOSANI BOTOSANI RIVERS Satu Mare Satu Mare MAIN ROADS MARAMURESMARAMURES SiretSiret Botosani Botosani SATU MARE SATU MARE SUCEAVASUCEA RAILROADS Baia Mare Baia Mare C Suceava Suceava M Somes a o PrutPrut COUNTY (JUDET) AND MUNICIPALITY To To BISTRITA-BISTRITA- r (MUNICIPIU) BOUNDARIES p l Chisinau Chisinau a I A S Id INTERNATIONAL BOUNDARIES To To NASAUDNASAUD a IasiIasi Budapest Budapest Oradea Oradea ZalauZalau DejDej Bistrita Bistrita BistritaBistrita t h v SALAJSALAJ i Piatra-Piatra- i To To 30°E HUNGARYHUNGAR a NeamtNeamt Chisinau Chisinau C L U J a n RomanRoman To To B I H O R Budapest Budapest Mures MOLDOVA Cluj- Cluj- MURESMURES NEAMTNEAMTM Vaslui aslui Napoca Napoca GheorgheniGheorgheni Târgurgu Târgu t HusiHusi MuresMures HARGHIT HARGHITA s . BacauBacau Crisul Turda urda Alb Miercurea- Miercurea- B A C A U V A S L U I Cuic Cuic A L B A SiretSiret Arad Arad A R A D OnestiOnesti To To BirladBirlad Subotica Subotica BradBrad Alba Alba Mures Iulia Iulia MediasMedias 46°N COVASNACOVASNA DevaDeva S I B I U UKRAINEUKRAINE SfSfântuntu Sfântu VRANCEAVRANCEA B Timisoara imisoara BRASOV BRASOV GheorgheGheorghe Tecuci ecuci LugojLugoj Hunedoara Hunedoara Sibiu Sibiu GALATI GALATI a T I M I S Timis HUNEDOARAHUNEDOARA MoldoveanuMoldoveanu FocsaniFocsani (2,544 m ) (2,544 BrasovBrasov SERBIASERBIA n PetrosaniPetrosani i a n GalatiGalati a l v a n s ARGES ARGES A l p s BUZAUBUZAU BuzauBuzau BrailaBraila To To t ResitaResita y n VÂLCEALCEA VÂLCEA Novi Sad Novi Sad Tulcea ulcea T r a CARAS - CARAS BuzauBuzau G O R J Râmnicu Râmnicumnicu Vâlcea Vâlcealcea PRAHOV PRAHOVA SEVERINSEVERIN Târgu Jiu Târgu Jiu rgu BRAILABRAILA Târgovistergoviste Târgoviste PloiestiPloiesti T U L C E A PitestiPitesti Jiu DÂMBOVIT DÂMBOVIT MBOVITA a Danube Orsova Orsova Drobeta- Drobeta- j Turmu Severin mu Severin W a l a c h i a ILFOVILFOV IALOMIT IALOMITA IalomitaIalomita Black BUCURESTIBUCURESTI u Slobozia Slobozia Slatina Slatina ArgesArges MEHEDINTI MEHEDINTI BUCHARESTBUCHAREST FetestiFetesti r To To Sea NisNis Craiova Craiova O L T b Navodari OltOlt CALARASICALARASI CalarasiCalarasi TELEORMANTELEORMAN MedgidiaMedgidia 0 25 50 75 100 Kilometers Danube o Constanta 44°N D O L J GIURGIUGIURGIU CONSTANT CONSTANTA CaracalCaracal D 44°N 0 25 50 75 Miles CalafatCalafat Alexandria Alexandria Giurgiu Giurgiu Mangalia IBRD FEBRUAR Turnu Magurele nu Magurele This map was produced by the Map Design Unit of The World Bank. 33469R2 The boundaries, colors, denominations and any other information Y shown on this map do not imply, on the part of The World Bank 2008 Group, any judgment on the legal status of any territory, or any To To To To endorsement or acceptance of such boundaries. 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